In an effort close off tax avoidance loopholes, the Chancellor, George Osborne, has turned his attention to the property market in the Budget. This highly lucrative business sector is seen as an area where investors can legitimately avoid tax at present and hold onto their cash by careful manipulation of figures and terminology.
For example, those in the know very often have chattels (fixtures & fittings) itemised and paid for separately, thereby reducing the price of the property. As the value of the property decreases, so too does the stamp duty payable on it and, in some instances, the property value even drops beneath the stamp duty threshold of £125,000, which means the buyer can avoid the tax completely!
This is just one example of the manipulation of the system to suit individual needs and Mr Osborne has taken the first steps in eradicating these opportunities with a number of measures which have collectively coined the colloquialism “The Mansion Tax”.
This so-called “mansion tax” was announced in the Chancellor’s budget on Wednesday, 21st March 2012. This will see stamp duty of 7% imposed on properties bought for £2 million or more from the previous rate of 5%, which has been in existence since 2011. The new rate came into effect from 22nd March 2012. This means that if you bought a property worth £2 million on Monday, 19th March you would have incurred a stamp duty bill of £100,000, but the same property bought at the end of the same week would have cost an extra £40,000 in stamp duty! On the face of it this seems like quite a harsh measure, but a snapshot of homes bought in November 2011 shows that this would only have affected 0.2% of the market that month (121 properties), so it really will only impact on a tiny proportion of the overall property market.
The Chancellor has also moved to clamp down on investors avoiding stamp duty by purchasing homes through non-natural persons (companies). Any residential properties purchased in such a manner now will incur a punitive charge of 15%. The government is also consulting on whether to introduce a new annual levy of an unspecified amount, on properties valued at £2m and above held in such structures, unless the owner is a developer.
Buyers need to consider all the tax implications carefully when deciding on whether or not to use a company to purchase a UK property. For example, the stamp duty now on a £2m home bought through a company would be £300,000 payable on purchase, after the UK government's latest increase in duty to 15%. If the buyer purchased the property in their own name in order to avoid the 15% rate and avail of the 7% rate instead, the stamp duty would be £140,000. But there is a significant sting in the tail further down the line with this option, as IHT at 40% (Inheritance Tax) would become due on death, which would add a further tax cost of £800,000! However, the IHT can be avoided with careful tax planning.
This is not the only benefit that remains when buying a property through a company and as well as the confidentiality afforded to the owner, the property may then be sold with a transfer of shares, which avoids stamp duty and other costs such as HM Land Registry fees.
Mr Osborne’s tough stance was further underlined when he claimed that he “will not hesitate to move swiftly, without notice and retrospectively if inappropriate ways around these new rules are found. People have been warned.” Only time will tell if his no nonsense approach will pay off and it will be interesting to see if wealthy investors find new loopholes to exploit in an effort to avoid tax, and what the Chancellor does about them when brought to his attention.
It is clear though that the Chancellor means business and he has taken the fight not only to the domestic market, but also to overseas investors. From April 2013 residential properties worth £2 million or more owned by overseas companies will attract capital gains tax, regardless of when they were purchased. It is estimated that properties owned by offshore companies would earn the Treasury half a billion pounds in tax each year if they were owned by UK companies or residents. In some areas more than one in twenty properties is owned by non-UK residents.
Of course, capital gains tax is only incurred when an asset is sold, so it will be interesting to see what overseas companies do with their assets over the next twelve months. Many might be tempted to dispose of them now rather than incur a tax bill of 18% on any income gains within the basic rate band (up to £37,400) and 28% on all income gains above that band. Others may decide to sell at a cut-price below the £2 million mark if the loss is less than the tax they would end up paying by selling at market price. Others may decide to hold onto the assets indefinitely if the benefit outweighs the cost in the long run.
Another loophole the Chancellor has closed off in the budget relates to offshore trusts.
Non-UK domiciled individuals who settle foreign assets into a trust ("excluded property" trusts)* can normally benefit from an inheritance tax (IHT) exemption in relation to those assets. The Government is targeting IHT avoidance schemes where UK domiciled individuals acquire an interest in a pre-existing excluded property trust in an attempt to secure IHT benefits similar to those enjoyed by non-UK domiciled settlers.
The new measures will ensure that assets acquired by a UK domiciled individual in this manner will be treated as if they were, at the point of acquisition, transferred by them to a UK trust. This will mean that, on acquiring an interest in settled assets, the reduction in value of the UK domiciled individual's estate is immediately chargeable to IHT and the settled property is subject to periodic and exit charges.
This will affect individuals (or their executors) and trustees who enter into schemes which involve a UK domiciled individual acquiring a life interest in an excluded property trust. Periodic and exit charges will apply to all new and pre-existing arrangements. In addition, an IHT charge, based on the reduction in value of a taxpayer's estate, will apply to all acquisitions which take place on or after 21 March 2012.
There is no doubt that these new rules will provide food for thought for investors and all the pros and cons will need to be weighed carefully before deciding how to proceed. Then again, that is always the case and shrewd investors, with the right help, will find the right answers.
It’s certainly not all doom and gloom, and in many ways, the government’s steps can be seen as an endorsement of the health of this lucrative business sector. The property market in the UK, particularly in London, is still far more buoyant than most other European markets. The City of London also still remains the major financial hub of the continent and offers many other attractive elements such as top schools and universities, excellent global transport links and easy access to some of the most vibrant service industries in the world. With the summer Olympics and the Diamond Jubilee only a few short months away, there is much to recommend the UK, especially London, as an investment destination.
*The Excluded Property Trust provides a way of protecting investments held outside the UK while you are non-UK domiciled so that, even if your status changes in the future, they will not be liable to UK inheritance tax at your death. The trustees have full control over the investments and are able to make payments to any beneficiary, including you as the settler, at any time. The trust can also provide inheritance tax protection for your beneficiaries, even if they are UK domiciled. The investments will not form part of their estates until actually distributed to them, so any that remain in the trust will not be liable for UK inheritance tax.
To find out how the Chancellor’s budget may affect you and your business, please contact our Business Consultancy team at Law Firm Ltd on 020 7907 1460 or via email on firstname.lastname@example.org.